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Is Lloyds Banking Group PLC A Better Buy Than Banco Santander SA?

Lloyds

It’s hard to deny that Lloyds (LSE: LLOY) (NYSE: LYG.US) is an intriguing prospect. While RBS — the other UK state-backed lender — posted a pre-tax loss of £8.2bn on increased provisions for mis-selling and litigation, Lloyds returned to profitability in 2013.

Shares in Lloyds have more than doubled in value in the last two years, and the share price will likely increase further still, once the remaining two overhangs are lifted.

First, after the government announced the sale of a further 7.5% stake to institutions, reducing its holding to 25%, Lloyds is that much nearer to returning to full private ownership.

The bank is close to standing on its own two feet again, and should the economic recovery prove robust, earnings should continue to improve in 2014.

LLOYLloyds’ boss, António Horta-Osório, decreed that the bank is now “normal”. Having simplified the business, creating a low-risk retail and commercial entity, his claims almost ring true.

But it would’ve been nice if, after the headway made, Lloyds had resumed dividend payments. This is the other overhang, and the bank will seek regulatory approval later this year to restart payouts, with a medium term goal of paying 50% of sustainable earnings.

Should payments hit this level by 2015, then investors could be in line for a potential yield of 5.3%

Santander

Earlier this year Banco Santander (LSE: BNC) (NYSE: SAN.US) announced a 90% increase in profits to £3.6bn. The bank has shed assets while strengthening its capital rating, and like Lloyds the Spanish bank’s profitability is due in no small part to an upswing in the domestic economy.

Spanish companies are bullish after the economy returned to growth in the third quarter of last year, and the worst of Spain’s financial crisis looks to be over.

After a significant drop-off in bad loans, requiring fewer provisions, Santander has promised “a period of strong profit growth in the coming years”.

The concern, for me as an investor, would be trying to assess whether Spain’s recovery will take hold.

It’s difficult enough, despite a keen interest in UK Plc, for me to try and gauge the strength of UK recovery. This is with plentiful access to the latest — often conflating — news reports.

santander(By that token, what appeals to me most about Lloyds is the potential for the share price to appreciate in the medium term, and of course the dividend potential. Longer ahead, outlook is more murky.)

Although, speaking of dividends, Santander does offer a prospective yield of 8%. That’s huge, but it’s barely covered by earnings (1.1x), although there are plans to redress this.

Are the banks a 'buy'?

There's an old adage, "invest in what you know". The banks could prove lucrative, especially at beaten down prices, but be sure to understand the potential pitfalls.

To assess your chances of making a profit, I recommend you read "The Motley Fool's Guide To Investing In Banks".

This free report contains essential information on how to value a bank, which is often tricky for non-exeperts.

For your free copy -- while still available -- simply click here.

Mark does not own shares in any company mentioned.